It is a well established fact in manufacturing that as experience is gained through production, unit costs are reduced. Originally, this cost improvement was attributed to a learning effect among workers such as the division of labor effect noted by Adam Smith (i.e. the development of a skill or dexterity when a single task was performed repetitively). Now, however, the effect is recognized as resulting from a wide variety of additional sources, such as changes in production methods and tools, improved product design from the point of view of producing, standardization, changes in layout and improved flow, economies of scale, better inventory control, improved scheduling and plant utilization, and improvements in organization. Actually, the worker learning effect is one that usually occurs rather quickly.
Strategic Implications of the Experience Curve:
The experience curve is particularly important in productivity improvement results during the rapid development and mature phases of the product life cycle, usually when the system is product focused. Especially during these phases, an understanding of the effects of experience can be used effectively in strategic planning.
First, the firm that has the largest market share will produce the largest number of units and will have the lowest cost, even if all firms are on the same percentage experience curve. Second, if through process technology advantages a firm can establish itself on a lower percentage experience curve than a competitor, it will have lower unit costs even if both firms have the same cumulative output. Third, a firm with greater experience can use aggressive price policy as a competitive weapon to gain an even greater market share. Fourth, a form can use aggressive process technology policy by allocating resources toward mechanization in earlier stages and automation in later stages of growth to maintain its position on the experience curve or to improve the slope of its experience curve. This strategy is particularly important in the mature phase of the product life cycle where competition is focused on cost.
Limitations of the Experience Curve:
Perhaps the greatest limitation of the experience curve is that the benefits finally run out simply because of product obsolescence, as is indicated by the product life cycle curve. But even before maturity is reached, the cost reduction due to experience will provide smaller and smaller returns. This is apparent from the shape of the curve; early experience provides larger returns, but as the product matures, it becomes much more difficult to obtain further cost reductions.
As the product goes through the stages of life cycle development, the productive system also matures, going through the stages of custom volume (job shop), to low volume (batch) high volume and very high volume (systems with a product focus). Another way to view what is happening as the productive system evolves is to note that it is becoming much less flexible and more and more capital intensive. This evolution is a large part of what makes the experience curve work, but at the same time, it makes the firm vulnerable to radical changes I consumer tastes and product obsolescence.
Experience Curve for Process Focused Systems:
In process focused systems, we do not have the opportunity to learn what comes from constant repetition of an activity. Also, the lower volume makes it less likely that improvements will result from mechanization and automation or from flow improvements in layout.
Nevertheless, there is cost improvement in these kinds of systems. Process focused systems learn how to serve their customers and clients better through improved order processing, better labor assignment and scheduling, better tool design, improved layout, and so on. The results of experience are more difficult to document because we do not have a specific product produced over a period of time for which we can accumulate cost data. Nevertheless, the cost improvement phenomenon exists in process focused systems, though the net effect is less dramatic than it is in product focused systems.